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Turkish Lira denominated Government Bonds yielding in the 7.5% range for 2 years

Investors should consider foreign denominated debt for the following reasons:

Instability of US fiscal and monetary policy

Diversification can reduce overall portfolio risk and volatility

Investors seeking higher interest rates are looking abroad

US economy may be entering a stagnant growth period

Globalization has added a risk/reward profile on sovereign debt.

It appears Turkey is positioned to enjoy economic growth in the future. It is one of the few top twenty economies in the world, measured by GDP output, with a yield in the 7.5% range. The Turkish story reminds of us our our successfully reviews of other economic success stories we have highlighted in the past including our review ofBrazilian sovereign debt which has done quite well.

Fixed income investors have been hurt with the global financial down turn. Yields are not what they used to be. The US Government is taking a position with there recently announce second round of bond purchases to keep yields artificially low while trying to reignite the economy. It seems as if the US Government is trying to “print” the economy back into action. By making more US Dollars available and keeping interests rates low, investors holding and purchasing fixed income instruments denominated in US Dollars are being hit with the double loss of historically low yields and principal depreciation due to inflation. What are investors to do? We have been finding higher yields with shorter maturities withglobal bonds.

During the late 1990’s and 2000’s, investors became familiar with the acronym BRIC which represented the emerging markets of Brazil, Russia, India and China. These countries were able to grow there economy robustly during that time frame. In the last two years, economist have coined the acronym CIVET for the next wave of emerging nations that include Columbia, Indonesia, Vietnam, Egypt and Turkey.

Investing in foreign bonds is not for everyone. These bonds are exchanged on global markets and the traders/market makers dictate what amounts they are willing to buy and sell. Currency volatility can cause large swings in principal value. Many ofDurig Capital's clients were asking for much smaller allotments in single foreign currency positions and we have found a way with hard work and excellent industry relationships. While working with multiple traders at different institutions, we have filled orders of $10,000 US dollars.

Country Overview

Modern Turkey was established in 1923 and has had different forms of government including authoritarian, military, and its current Democratic Republic. Located on two continents, Turkey’s geographic location is an important as it is an avenue between Europe, the Middle East and inner Eurasia. Turkey literally means “Land of the Turks” as about 70% percent of the 73 million people are ethnic Turks.

Political

Turkey has a governmental structure similar to other Westernized nations with respect to overall structure. The Turkish President is a symbolic position yielding little power. Executive power rests with the Prime Minister who is elected by the members of Parliament which is composed of 550 members and elected by the people.

The military plays an informal role in the government as they see that they are mandated to keep church and state separate. Since the formation of modern day Turkey, the military has been involved in four coup d’etats. As many outsiders think that the military could be a destabilising force, the general population opinion sees them as the most trusted branch of government. Since 1952, Turkey has been part of NATO. The Turkish Military is currently the second largest standing force in NATO with over 400,000 enlistees.

In the early 2000, political and economic instability recked havoc in the financial markets of Turkey. They had six Prime Ministers in as many years. Leadership was fragile without a clear path for the future. Inflation in Turkey was among the highest in the world. Foreign investors were spooked with the lack of stability and inflation. The government owed $23.5 billion to the International Monetary Fund alone. The financial sector in Turkey was on the brink of collapse and the whole economy went into recession.

Elections were held in 2003 which resulted in one party winning two thirds of Parliament’s sets for the first time in over a decade. Soon after, Recep Tayyip Erdoğan was elected Prime Minister and stability returned. Without having to form a coalition with anyone, the AK Party took control and economic, monetary and fiscal policy changed quickly. In 2002 the Turkish Central Bank had $26.5 billion in foreign currency. Just last year they reported they held over $70 billion. This helps illustrate that the reforms may be working.

On another note, Prime Minister Erdoğan engaged in accession negotiation with the European Union in 2005. There are many hurdles that must be met before membership is granted that include human rights, economic and political issues. Membership is not likely in the next decade however Turkey and the European Union continue to be engaged in talks.

Turkey opened accession negotiations with the EU in 2005 but is considered very unlikely to join in the next 10 years, partly because of opposition from countries such as France and Germany. Its refusal to recognise EU member Cyprus, growing support for pro-Islamic parties on the mainland and the treatment of the Kurdish minority in the country all remain potential stumbling blocks. Since 2005, only 11 out of 35 "negotiating chapters" relating to accession talks have been opened for discussion and only one has been "provisionally closed." Talks continue to be ongoing and open as Turkey motions toward membership.

Economy

The Turkish economy has developed greatly since the 1980’s. Actions taken have included privatizing corporations, adapting a flexible exchange rate, increasing exports while relaxing import regulation, deregulating financial markets and lowering the levels of corruption. These steps have assisted in Turkey being recognized by the US Department of Commerce as one of the top ten promising economies of the global emerging countries. Although there is still room to improve, these are very positive signals for a nation considered as emerging.

Turkey’s GDP, as measured in Purchasing Power Parody, is the 16th largest in the world just behind Canada and slightly larger than Australia which have done well sinceour review. The Turkish economy produced an estimated $1 trillion US Dollars in 2009. Since 2002, GDP has grown at an average rate of 4.5%. The government is currently estimating that it will continue to grow at a rate of 6.8%, 4.5%, 5%, and 5.5% for 2010 through 2013. For comparative purposes, the US Central Bank revised it’s growth projection downward to under 3% per year until 2013 for the US economy.

There are three financial trends that are occurring in Turkey that each on their own would be good but all trending illustrate the strength of the economic growth.

Inflation has been a large concern for Turkey and outside observers for a generation and has been an important factor regarding European Union membership. October 2010 inflation was reported to be 8.6%. For the period of 1996 to 2001, 71.6% inflation was reported. From 2002 to 2009, the average yearly rate dropped dramatically to 12.6%.although this number is higher than what Americans are use to it is trending closer to global averages.

Interest payments divided by total GDP output. The lower this number the better as it means it is cheaper to lend and or GDP grew. In 2002, this ratio was over 14% and has been steadily declining and has been below 6% since 2007.

Interest payments divided by tax revenue Similar to above, the lower the better. A lower number indicates cheaper financing or less financing. While the tax revenue can change by the government increasing rates or having a larger revenue base, it is our belief that true GDP growth, as seen in Turkey, will cause a larger revenue base. In 2002, it was reported that this ratio was nearing 86% while in 2009 it was a much lower 31%. This is indeed a positive sign.

With a favorable age demographic, 92% of the population under the age of 60, the young large work force is ideal for continued economic growth. The government expects the population figures to grow to 77 million by 2015. Since 2002, unemployment figures have hoovered between 10% and 11%. Over the last two years, Unemployment has inched up to 13%. The recent rise may be attributed to the global financial crisis, however if these unemployment rates could be reduced, growth prospects may be even better than current outlooks. Having a young growing working class is important to economic growth theories.

One ratio we like to assess when looking at foreign government debt is the general government debt to GDP ratio. Below one will find these numbers as reported by the Turkish Undersecretariat of Treasury. Since 2004, this ratio has trended downward----a good sign. It is important to note that it did increase in 2009 due to the global financial crisis. It is expected to remain constant for 2010. Current levels are still well below the 2004 reported ratio even after global credit lending froze and are currently better than many of the “Big Boys” in the European Union.

Turkish General Government Debt/GDP

2004

2005

2006

2007

2008

2009

2010

67.4%

59.2%

46.1%

39.4%

39.5%

45.5%

46%*

*denotes pundits estimates

In the recent news, Western European nations such as Greece and more recently Ireland have needed foreign assistance to stay solvent. Ireland recently asked the IMF and European Union for an estimated $110 million dollar loan. These loans are needed due to the Irish government backing of the fragile banking system. The Turkish banking sector, on the other hand, seems to be in a healthy state due partially to the deregulation that has been occurring since 2002. Without going into to much detail regarding private banking debt, Turkey seems have superior capital coverage similar to the Brazilian financial markets. From an outsiders perspective, it seems like fate of the Irish and Turkish banking systems are not the same.

The three independent rating agencies, Standard & Poor’s, Moody’s and Fitch, have each upgraded Turkey’s debt since 2005 and have established positive to stable outlooks. They currently have BB+,Ba2 and BB+ ratings from these three institutions. Although these ratings are below the industry standard of investment grade, we like to see the positive outlook and the recent historical upgradings. In the last few years, few sovereign debt issuers have been upgraded while many have been downgraded.

One of the criteria we review is the Heritage Foundations World Economic Freedom Rankings as we did with ourreview of Hungary. Turkey has a world rank of 67 meaning they score higher than the median global score. Although the ranking is not as high as Hungary’s, more importantly we focus on looking for countries with improving levels of freedom. Since last year alone, the score has move up from 61.6 to 63.8. Turkey has a very strong upward trend since reforms were put in place.

Conclusion

The currency and political issues could and most likely will, affect future returns. American government debt is experiencing massive growth with little apparent control while Turkish policies have been able to reduce their debt load in recent years. If you have followed our methodology over the weeks, it is easy to understand why we like issuers, corporate or government, with smaller amounts of debt and brighter prospects. As numerous academic studies have illustrated, diversifying ones portfolio will help reduce systematic risk. This is just another way for the investor to diversify away from a portfolio over weighted in holdings denominated in US Dollars. While being able to reduce the overall risk, a yield in the range of 7.5% for two years is phenomenal. Turkeys dynamic economic growth, geopolitical position between Westernized nations and Arab nations and their fiscal and monetary policy management gives the Lira a bright outlook compared to Washington's policy of weakening the US dollar in order to repay amassed US debt.

Disclosure: Durig Capital is currently recommending Turkish Government debt to it's clients.

International Bank Reconstruction and Development in Brazilian Real 6.89% YTM due 6/12

This week we are expanding our approach and highlighting a multinational non government organization. The World Bank has issued some fixed income instruments that offer higher yields, the highest ratings, an array of options in currencies to help our investors globally diversify their income streams.

In recent weeks we have had a lot of inquiries about investing in foreign denominated debt. Currently, the state of the US economy has many wondering what will happen next. The Government has accelerated it’s deficit spending with hopes of restarting the economy. These additional levels of debt and government growth could possibly provide a constantly prolonged weakening effect to the US Dollar. The Federal Reserve has hinted that it will keep interest rates at record lows to assist in the recovery process. Being able to lend at these levels is attractive although it also means it is hard for investors to generate current income. Unemployment continues to be newsworthy as levels still hover around 10%. With the US balance sheet, low interest rates, and high unemployment investors as seeking higher yielding issues. We have found an Institution in the World Bank that offers AAA rated bonds, higher yields, and foreign currency exposure that investors are seeking.

We have found one bond that is very attractive to us that is issued by the World Bank.

The following provides details about this issue:

International Bank of Reconstruction and Development

Denominated in Brazilian Real

Matures on June 15, 2012

Coupon of 8.75%

Price 102-24 Brazilian Real

Trades in lots of 5 bonds (5000 Real)

Exchange rate = .5917 US Dollar/Brazilian Real

Yield to Maturity of 6.89%

The World Bank is headquartered in Washington D.C. with 100 member offices in 130 different countries being represented by 10,000 employees. The World Bank does not have ownership stakes like common retail banks do but instead is owned and operated by 187 member countries.

One of the features that we like about the World Bank bonds is that they allows investors to diversify their assets out of US denominated assets. They offer bonds denominated in 51 different currencies with 62% of the bonds denominated in US Dollar. We previously wrote about a Brazilian Government bonds that matured in 2016 and highlighted the superior yields investors could attain. Investors requested bonds that had shorter maturities than the last, five plus years, issue we offered. While reviewing out options, we identified an offering at the World Bank that achieved our Real denominated exposure needs while having a maturity of 18 months.

One of the subordinated divisions of the World Bank is called the International Bank for Reconstruction and Development. The bank first started issuing bonds on global financial markets just after World War II ended in 1947. Since that time, the World Bank has had the the highest credit rating available of AAA. They have never needed to make a capital call or to write off a loan.

With such a strong credit rating, World Bank bonds are ideal for investors that look to gain exposure to interest rates, currencies, inflation rates, equity indices, and other indices. At Durig Capital, we are utilizing these highly rated debt instruments, gaining also higher yield, to limit our clients exposure to the US currency.

As of June 30, 2010, the World Bank reported paid in capital of $11.5 billion US Dollars with an additional $178.4 billion US Dollars that is considered callable capital. Callable capital is defined as pledges that member countries have made to the World Bank in case capital is needed to repay loans. About 38% of the callable capital has been pledge by the United States, Japan, Germany, France and the UK illustrating that the bank has a strong foundation and that not all the capital is linked to one country.

The way the World Bank diversifies its lending practices to different countries in also attractive to investors. No sovereign nation can lend more than 16.5% of the over all lending portfolio. This helps mitigate risks such as natural disasters and political unrest or revolution. Currently the largest lender in China representing about 13% of the overall portfolio with Brazil the second largest with just over 11%. The other larger lenders include India, Mexico, Turkey, Indonesia, Colombia, and Argentina.

One feature that we find very attractive about the World Bank is their conservative lending practices. Their rule is as follows “The World Bank can never lend more than subscribed capital, reserves, and surplus.” This year the estimated subscribed capital, reserves, and surplus is approximately $218 billion US Dollars while they have outstanding loans and guarantees of $120 billion US Dollars. As we have mentioned in previous articles, we like to see short term assets and cash that is greater than long term debt. In this case, short term assets and cash exceed total debt by over 180%.

Historically, the World Bank sold there issues to large pension funds and institutional investors. With the ongoing development of global financial markets that is occurring, issues that were once only offered to the above mentioned clientele are slowly becoming available to individual investors.

Funds generated from the issuance of bonds by the World Bank applied toward numerous projects. In 2010 alone, the World Bank is projected to lend $34 billion US Dollars. Last year represented the largest amount the World Bank financed for a year with $44 billion being financed. Much of last years activity was due to refinancing issues at reduced yields.

Risks

There is unique risks associated with bonds issued in a currency that is not the investors local currency. This risk is effected by numerous interwoven factors that include but are not limited to geopolitical, foreign trade, inflation rates, sovereign interests rates, currency supply and currency demand factors. Lately, US Dollar has been losing value to some foreign currencies due to some of the above mentioned factors however the past movements are not indicative of future performance. Principal and interest payments could adversely be affected by changes in the values of foreign currencies. We believe that investors could reduce the overall purchasing power risk of their portfolio if an allocation of foreign denominated debt were included in the portfolio. Brief Overview of Select Issues

Many foreign currencies like Brazilian Real require a 250 bond minimum purchase. We are working to provide our clients world income in smaller allotments. This allows individual clients the high yielding world investments, with the ability to properly weight the assets allocations with regards to their own portfolio. In the past we have been able to purchase $10,000 US Dollar.

The World Bank bonds give investors a premium yield. The highest AAA ratings and a strong balance sheet tell us default risk is minimal. We believe receiving a high yield, diversifying away from the dollar and minimal credit risk could be an excellent way to protect against the probability of a prolonged fall of the US dollar.

Disclosure: Durig Capital and it’s clients currently do have positions in World Bank bond issues.

Since the current price is $8.67, that works out to be a 67% gain since November. Additionally, we have reviewed Sonic's position. We believe both their balance sheet and their business model failed on our reviews. We are not saying that Sonic is a bad company, but rather that we only want companies that fit into our proven model. With that said, we will be preparing our exit strategy.

They are paying $3.75 a share in cash which is below what DivX already had and .514 Sonic stock. This currently works out to a combined value of $9.19.

On November 13, we explained that a price for DivX of $5.26 per share was far too low, considering the cash of DivX alone was around $4 per share, and, well, Sonic Solutions (SNIC) seems to agree as they are willing to pay over $9 a share!

Even though the price is 67% higher than when we first took interest, we believe that DivX could have received more and/or joined or found possibly a stronger merger partner. Although with the total price Sonic is paying and knowing the business model, we believe Sonic will do very well with this merger.

We are pleased to find companies that fit our model of low values, strong earning and outstanding short term performance - which has attracted so much interest as both rumored and real buyouts, helping to further improve our strong clients' performance.

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